From High Frequency Trading To A Broken Market: A Primer In Two Parts

One of the topics most often discussed on Zero Hedge before the wholesale takeover of capital markets by central planners was finally accepted by everyone, was the domination of market structure (first in equities, and now in commodities, FX and even credit) by new technologies such as High Frequency Trading as a result of a shift in the market to a technological platform domination, away from the specialist model, and one where the entire concept of discounting, the primary role of the market in the Old Normal, has been made redundant courtesy of a race to be the first to react to events (i.e., backward looking, and direct contravention with the primary function of markets) courtesy of milli- and nanosecond, collocated servers which collect pennies in front of steamroller and generate profits purely by "virtue" of being the first to trade.

This new "technology paradigm" developed in the aftermath of the regulator complicit adoption of Reg NMS (and to a smaller extend Reg ATS) which unleashed a veritable cornucopia of "SkyNet"-controlled algorithmic traders, even as regulators did not and still do not, to this day understand all the evils that rapid technologization of the stock market has brought, most vividly captured in the May 2010 flash crash, and daily subsequent mini flash crashes, which have achieved one thing only: the total collapse of faith in the stock market by ordinary investors, who now see it for what it is (and always has been but to a far lesser extent) - a gamed casino, in which not only the house always wins and the regulators are either corrupt or clueless, or both.

And while more and more "dumb money" Joe Sixpacks awake every day to the farce that is the stock market, one entity that continues to ignore it, whether due to its own incompetence, due to conflicts of interest, due to corruption, due to co-option, or for whatever other reason, are the regulators, in this case the Securities and Exchange Commission: arguably the most incapable entity to handle the topological nightmare that the current market landscape has become. Which is to be expected: after all only an idiot would expect that when the SEC invites a GETCO, or a DE Shaw to explain and observe the fragmentation of the market, and the evils brought upon by HFT, either in a closed session or before congress, that they would voluntarily expose their business for the parasitic fallout of what once was known as capital formation. After all, it is their bread and butter: to expect them to commit professional suicide by truly showcasing the ugliness beneath it all is beyond stupid. And the flip side are various fringe blogs, which must be relegated to the tinfoil crackpot ranks of conspiracy theorist (even as conspiracy theory after conspiracy theory becomes conspiracy fact after conspiracy fact).

So instead of uttering one more word in a long, seemingly endless tirade that stretches all the way to April 2009, we will this time let such dignified members of the credible, veritable status quo as Credit Suisse, who have released a two part primer on everything HFT related, with an emphasis on the broken market left in the wake of the "high freaks", which is so simple even a member of congress will understand (we would say a member of the SEC, but even at this level of simplicity its comprehension by the rank and file of the SEC is arguable). As Credit Suisse conveniently points out "market manipulation is already banned", but that doesn't mean that there are numerous loophole that HFT can manifest themselves in negative strategies that have virtually the same impact on a two-tiered market (those that have access to HFT and those that do not) as manipulation. Among such strategies are:

Layering: multiple, large orders are placed passively with the goal of “pushing” the book away

Order Book Fade: lightning-fast reactions to news and order book pressure lead to disappearing liquidity

Momentum ignition: an HFT trader detects a large order targeting a percentage of volume, and front-runs it.

So to all those who still foolish believe in a fair and efficient market: read on, because that concept died long ago, and every day you keep money in the market is one more in which the deck is stacked entirely in the house's favor, and on a long enough timeline, a total loss of capital is virtually assured.

And for all the regulators, who are somehow still uncorrupted, unconflicted and uncoopted - those very, very few of you - and who still harbor a hope that one day retail investors may regain their faith in the stock market (a critical milestone needed to enable Bernanke's plan of rekindling the "animal spirits"), read on so you too can now what should be the focus of both regulation and enforcement in a world in which government supervision is several decades behind the curve.

Part 1: High Frequency Trading – The Good, The Bad, and The Regulation

It is a good question though, but it would have to overcome a few things - namely, captured regulators and a system intent on keeping the worst aspects.

It isn't impossible. If someone decided to sit down and write a decentralized exchange that could scale and handle the quote/volume requirements, but at the same time ban quote-stuffing and other strategies, I think that person would easily be the most famous person in the world.

The Equity Markets have gotten so far astray of their original purpose and intention that it is now a parody of itself. It is only through incrementalization that the absurdity of it all is not seen as glaringly surreal. It was not all that long ago (60's?) when the practice of equity "derivatives" was first introduced. At that time many traders balked at the concept of packaging equities as commodities to be traded via "futures" contracts. Today, the trading of stock derivatives is mundanely "de rigueur" as MUCH more esoteric(and risky) instruments and practices have evolved.

this whole thread is focussing on effects, not focussing on root causes.

When you say that "central planning took over the economy" you momentarily forget what preceded that truth : Under Reaganomics and deregulation the "free market", aka Oligarchy order, took over the world economy in fiat dissemination mode; based on "unlimited economic growth" meme decreed by NWO, under its military hegemony of massive overkill imposed on world subsequent to Berlin Wall fall, and USSR meltdown world.

The Central planned economy was the KNEE JERK reaction by Oligarchy to take over OVERTLY de facto the reigns of central government (under the WMD financial gun; aka Paulson TARP blackmail). After the 2008 fall of free-for-all Oligarchy "asset on steriods" mayhem of which Subprimes was only a trigger.

WE ARE ALL KEYNESIANS IN RECESSION TO AVOID THE 1929 TYPE DEPRESSION, AS THE recent BRUCE KRASTING article points out so eloquently. SO Central planning is the only way to avoid the depression caused once again by the thieving free enterprise head-up-their exuberant ass Oligarchs; now gone viral into deep rehypothec criminality and Libor rate wanking, and ZIRP fed speculative levitation. VOODOO finance!

Now in control, both of private sector, deep in derivative concocted debt, but deep in off-shored profit as well, and Oligarchy imposed government sector siphoning of the shadow banking debt like a huge oligarchy phallic suction whore, we have got the regime of central planned economy to socialise the debt and privatise the profit in all of first world.

It has been the privilege of ZH to have exposed this SCAM of unimaginable magnitude of western civilization wealth to the world.

SO it is surprising to see the same people who have exposed this mechanism of global rip-off, now ONLY addressing the issue of the central planned suction pump result; without also including in that sequential analysis the origin of the Oligarchy scam which is home and dry; sitting in Caymanista land, and ready to come back and rule the world once its statist surrogate shills have run out of fiat bullets...whatever the consequences they win unless there is rule of law and legal consequences for past ill doers; KAFKAIAN FANTASY IN CURRENT POWER CONSTRUCT.

Is there an ideological shift in the perception of ZH?

Yes, its essential IMO is to keep sanity and sequential balance on this awesome global mayhem thread called Pax Americana unwind.

The issue is NOT the effect of Central planning fiat inflation, its the root of Oligarchy evil sitting in the aisles, hoping against hope that the imposed austerity cum inflation of fiat pump will somehow save their stashed wealth, like the gold of the Aztecs/Incas robbed by the Spanish COnquistadors of old. Its not FDR who caused the 1929 crisis it was the Oligarchs and it had unimaginable consequences on the world. The same is true today, and its four times more lethal.

Lets keep things in perspective; cause and effect.

Not that i do not enjoy your analytical skills, but it lacks synthesis and overall perspective.

They, the Oligarchs, DONT want to go down the Zero Hedge road for sure. Lets not forget that ORIGINAL SIN and its origins.

Good job Atomizer/ I liked it ;-)... This HFT stuff is fascinating,once you start to understand what it's intensions are, and how it's used. I'll tell you one thing! HFT does not increase liquidity in the markets. It's all just an illusion, with ghost bids and asks that never get filled/ until the airpocket hits a top or bottom<>

So who are these Oligarchs ? Come on Tonto, lets form a posse and go find them and lynch them ! Hi-ho Silver , away (William Tel overture music in background). However, in real Wall St life the bad guy always wins---- until we form a posse. The SEC is more like the Town's intoxicated Doctor who is supposed to take care of the citizen's health needs but would rather stay at the bar drinking with the polititians.

"Momentum ignition: an HFT trader detects a large order targeting a percentage of volume, and front-runs it."

What is the dark pool institutional investor doing? Hiding their large share block trades so that they don't spike up price, to front run later news that will later drive up price, after they finish accumulating.

Does Buffett announce he is going to buy XXX? No, he buys XXX, then lets the public know he bought XXX, sending them to spike up the price.

If the market is broken, when did it break? Were people saying the market was broken when 20% annual gains were the norm? Or is the market only broken when it is in a secular bear market and isn't only going up?

Markets evolve over time. Pit traders give way to electronic traders. Human psychology does not evolve. Greed and Fear.

The greater fool. Someone always gets in ahead of someone else. Virtually no one buys at the exact bottom.

Buy the break out. Well what has to happen before one can buy the break out? The price has to come up to the break out point. Someone else gets in early. But what is the trader trying to do? Make money. If one buys low and the price drops lower still, has any money been made? With CANSLIM one buys high and sells higher. They are not looking to get every penny.

If a stock goes from 10 to 40 and HFT's have been playing the stock all the way up, if one bought it at 14 and sold it at 36, how much money has one made, with or without HFT's in the market?

"WE ARE ALL KEYNESIANS IN RECESSION TO AVOID THE 1929 TYPE DEPRESSION, AS THE recent BRUCE KRASTING article points out so eloquently. SO Central planning is the only way to avoid the depression caused once again by the thieving free enterprise head-up-their exuberant ass Oligarchs; now gone viral into deep rehypothec criminality and Libor rate wanking, and ZIRP fed speculative levitation. VOODOO finance!"

How is that depression being avoided? Food stamp recipients just hit a new all time high at 47.7 million.

How is the FED manipulating interest rates, free enterprise? In free enterprise, the market sets the rate through price discovery. ZIRP is not free enterprise. You are blaming free enterprise whn you should be blaming market manipulation.